Q: Since I don’t have a large downpayment, is a seller-financed deal a better way to get a house sale done? I have a home I own free and clear that I want to rent out and have it pay for my next home. What would you recommend?
A: Seller financing both is and isn’t the panacea to the challenges involved in financing a home that so many people think it is. With a seller-financed transaction, many of the seemingly technical, formal, tough-to-complete requirements imposed by institutional mortgage lenders are potentially eliminated.
Downpayments, appraisals, condition requirements, even title insurance and private mortgage insurance — seller-financing provides a means to escape the burden of these requirements.
Well, kind of. While sellers can offer to hold a note or carry back financing on a home on terms that are more attractive to the buyer, for whatever reason the reality is that most sellers either (a) have an existing mortgage they need full payment to pay off, or (b) need at least a very large upfront payment to move on to the next phase of their lives, and to make it worth their while to forgo full upfront payment and the closure of being done with the property.
So, in addition to the fact that seller-financing is simply not that frequently available, the sellers who are willing and able to finance the sale of their homes often require more of a downpayment than a corporate lender, not less.
Additionally, many of the seemingly burdensome guidelines and requirements imposed by institutional mortgage lenders are actually safeguards that protect the interests of not only the lender, but also the buyer/homeowner.
Title insurance ensures that the seller has the legal right to sell you the home, and offers you some financial protection in the event there are defects in the title.
The title search conducted by the title insurance company before closing can also prevent a buyer from making a downpayment on a seller-financed transaction to buy a home that is mortgaged beyond any hopes of being paid off out of the current transaction, or even worse, is soon to be lost to foreclosure.
The appraisal process — warts and all — does provide for a professional evaluation of a home’s value. Even though the disconnect between appraised value and purchase price can be the bane of a buyer’s existence when the buye is trying to secure a mortgage, in the context of a seller-financed transaction an appraiser’s opinion of the home’s value can prevent a buyer from making an uninformed decision to dramatically overpay for the home.
Also, buyers of seller-financed transactions need to be proactive and personally ensure that their post-transfer deed is filed with the county recorder’s office. Otherwise, the seller can continue to take mortgages out and even lose the home in foreclosure.
There is a long-persistent fallacy/fantasy among Americans that owning one home can and will pay for the next. While it is possible, it is also outdated. That was more feasible in the decades when home prices and the total costs of ownership were much lower than they are, even in their currently, relatively low, post-bubble state.
Before you fall into this fallacy, get extremely nit-picky with your calculated income and expense projections.
If your current home cannot produce sufficient cash to pay for the downpayment on your next one, then it isn’t truly paying for the next home. If you think the rental income from the one will cover your mortgage payment on the next, that’s certainly possible, but make sure you account for the rental income to cover that home’s maintenance, repairs, property taxes, and hazard insurance.
Also — in an ideal world — build up a reserve account in case you have a few months of vacancy, a few months were the tenant doesn’t pay, and/or a situation in which you need to evict a tenant. It happens. I’ve certainly seen many a landlord have their personal finances derailed by having to pay legal fees for an eviction.
So, what’s my recommendation? Certainly keep an eye out for seller-financed opportunities but more importantly, keep an ear out for people you might know who need to offload a property and are willing to do so with little or no cash upfront from you.
And, if you do end up trying to use seller-financing for your next home, retain a local real estate attorney who can help you take the needed precautions.
Also, before you decide that your current home can pay for the next one, do some meticulous cash-flow projections on it to ensure you’re not getting yourself in over your head, and consider taking a year or so to save up some reserves.